When a trader uses leverage, they post margin as collateral for a position larger than their own funds. If the market moves against that position and losses shrink the margin down to a maintenance threshold, the exchange or lending protocol will step in and close the position automatically, without waiting for the trader's confirmation. This exists to stop losses from exceeding the collateral put up and, in most designs, to protect the platform's own solvency.
The price at which this happens is called the liquidation price, and it moves closer to the entry price as leverage increases, since there is less margin available to absorb losses. In decentralised finance, liquidations are often carried out by independent participants who are financially incentivised to spot and close under-collateralised positions quickly, usually in exchange for a fee taken from the liquidated collateral.
During sharp, fast market moves, many leveraged positions can be liquidated in a short space of time, and the forced selling or buying from those liquidations can itself add further pressure on price, a pattern often called a liquidation cascade. For this reason, traders who use leverage generally treat liquidation risk as something to actively manage, for example by using lower leverage or adding margin, rather than something to discover after the fact.
Key takeaways
- Liquidation is an automatic, forced closure of a leveraged position once losses erode the required margin.
- Higher leverage pushes the liquidation price closer to the entry price, leaving less room for the market to move against the trade.
- Clusters of liquidations during sharp price moves can add extra selling or buying pressure of their own.
Liquidation — frequently asked questions
Can a trader do anything once liquidation is triggered?
Once the liquidation threshold is reached, the process is typically automatic and cannot be stopped. The only way to avoid it is to act beforehand, by adding margin, reducing position size, or closing the trade voluntarily before the threshold is reached.
Does liquidation only apply to crypto exchanges?
No, the same mechanism exists in traditional leveraged trading such as margin accounts and futures. In crypto it also appears in decentralised lending, where under-collateralised loans, not just trading positions, can be liquidated by the protocol.
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